Misalignment in the growth-maximizing policies under alternative assumptions of tax evasion

Abstract:

Using an overlapping generations monetary endogenous growth model, we analyze the possible
misalignment in the growth-maximizing policies if tax evasion is assumed to be exogenous instead
of being treated as a behavioral decision of the agents. By allowing for government transfers to
affect young-age income, and, hence, a role for monetary policy, besides fiscal policy, in the
determination of the agents reported income, we show that the failure on part of the government
to realize tax evasion as endogenous, results in higher tax rates, reserve requirements and money
growth rate. This, in turn, implies that the economy would end up experiencing lower (higher)
steady-state growth (inflation).